The government on Monday proposed to increase the service tax on life insurance policies to 1.5 per cent from 1 per cent, a move that would increase the premium cost for policyholders.

"It is being provided that tax shall be charged in the portion of the premium... the composition rate is also being increased from 1 per cent to 1.5 per cent," Finance Minister Pranab Mukherjee said in his 2011-12 Budget speech.

"In case of traditional endowment plans, the service tax rate has been increased from 1.03 per cent to 1.545 per cent.

Although the increase is marginal, there could be some increase in premium or returns might be lowered," Max New York Life Insurance CEO & Managing Director, Rajesh Sud said.

In the traditional endowment life insurance products where it is not possible to segregate the mortality premium and the premium attributable to investment, service tax is payable at a gross rate of 1 per cent of the total premium.

However, the life insurance industry, which was demanding special treatment in the Budget for increasing investment in insurance polices, was unhappy with the move.

"This is not in line with our request for fiscally supporting long-term savings contracts such as life insurance," Sud said.

However, global consultancy firm Ernst & Young's Ashvin Parekh feels that the extension of service tax to services provided by life insurance companies in the areas of investment and health checkup or treatment will not have a substantial impact.

"The changes will extend comprehensive service tax coverage to all the services provided by life insurers and hospitals for health insurance," said Parekh, who is the head of Global Financial Services at E&Y.

Traditional insurance policies invest at least 65 per cent of the funds in Government Securities and Infrastructure Bonds, and provide fixed benefit to policyholders.

Commenting on the Budget, Kotak Mahindra Old Mutual Life Insurance Chief Operating Officer G Murlidhar said that the taxable service, which was previously restricted in relation to only "risk cover" in life insurance products, has been extended to all services.

"The burden of service tax on the policyholder is bound to increase and will result in lower returns to the policyholder," Murlidhar said.

The Budget has, however, provided Service Tax exemption to Rashtriya Swasthya Bima Yojana under the general insurance service.